Knee-Jerk Wisdom Can Be the Most Expensive

This may end up being one of my favorite case studies. It’s an ongoing file. I’ll be changing names, and some facts that won’t change any outcomes in order to maintain their privacy. These are real folk, wicked smart, and just now writing the first few chapters of their family’s story. I really like ’em.

Dave and Nicki are both in their early 30’s, both professionals making six figures, and the proud parents of two month old Langley, their first child.

Between them they’re putting in over $2,000 monthly into their 401k’s. After comparing two scenarios — A) Continuing the status quo, i.e. the current monthly contributions to qualified retirement plans. OR B) Gut his plan (hers too if I had my way), pay the taxes/penalty, and leave that flawed strategy in the dust. I’ve recommended Plan B, which they’re considering. First step in the process was hittin’ up their accountant for advice.

I’ll give ya three guesses as to what he told ’em, and the first two don’t count. 🙂

To quote Dave, the guy was “quite adamant” about not doing this. I’m guessin’ Dave buffered the guy’s response a bit. The accountant calculated that the net would only be half of the money taken out, after taxes/penalty was paid. I’m not sure of that, but we’ll use it just the same. I’m bettin’ their accountant is a real pro, knows his stuff, and has their best interests at heart.

He’s just dead wrong in this case, in my professional opinion.

Anywho, with that money, they’d be able to buy a couple income properties. They’d hafta add a bit to make it work, but not all that much. The props would cash flow from Day 1 easily. Giving them a 15-25 year window to pay them off, the debt free cash flow would be in excess of $3,000 monthly between the two properties.

Then there’s the question of the $2,000 a month no longer being shoveled into the 401k. What to do? Hey, I has a idear, let’s pile that money into an EIUL — duh. Here’s how it works out.

Note: Dave puts $24,000 yearly into the EIUL for 20 years, then let’s it simmer another five years. That’s the same amount he was puttin’ into his qualified plan at work. That puts him at 57 years old. He then pulls the ‘income trigger’ and starts collecting tax free income.

The Payoff

Some time in the 15-25 year window, the duplexes were paid off. The timing is up to Dave and Nicki, of course. The income, assuming no increase in NOI (Net Operating Income) would be just over $37,000 a year, around $3,000 monthly.

At the end of 25 years, about age 57, the EIUL is triggered, and the annual tax free income from that comes to $168,000. Again, don’t pass over it — tax free.

I Double-Dare Ya

I’m gonna skip tryin’ to explain to those who’ll immediately start complaining about losing all those years of tax savings derived from the annual 401k contributions. I’m sure, given the results of my strategy, Dave ‘n Nicki would be more than content allowing you to have all of it. 🙂 But here’s my challenge to those who remain in the 401k camp.

Please show me how you’re gonna generate $205,000 a year from your 401k in the next 25 years — roughly 92% of which will be after tax income.

What must happen on 401k scenario

In order to generate an income at retirement of $205,000, and assuming a yield of 6%, (which btw, is 2% more than the gods of Wall Street predict most of the time) Dave ‘n Nicki would have to have built up their 401k to to — wait for it — here it comes — a skosh over $3.4 Million. Oh, wait. That entire yield is completely taxable. Think at least $4 Million to net the same as the strategy I’ve recommended.

Really? Who’s raisin’ their hand to claim they’re gonna make that happen in their 401k?

Even without one measly losing year in the next 25, does anyone seriously think they’re gonna be the one in 10,000 (probably more like 1 in 100,000) who ends up with $4 Million in their 401k? If you can do that, tell us your secret cuz there’re 70,000+ readers here who we be all ears.

All this and this income will merely be in addition to what the remainder of their plan generates. If they follow the plan and are as disciplined as they’ve obviously been up to this point, they’d have to screw up not to end up within shoutin’ distance of a $300,000/yr retirement income — the majority of which will be after tax money.

So, like I was sayin’ — gut your freakin’ 401k/IRA and get serious about your retirement. 🙂

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7 Comments

Great analysis. To further the point…some back of the envelope calcs help throw more light on their situation. Using a 6% return, their 401K should worth around $1.39M (again, assuming 6% year in and year out on $2,000 per month contributions). If they continue to earn 6% through retirement, that would yield just north of $83K per year, gross (but who stays in the same investments in retirement as they had pre-retirement?). Net of a low estimation of 15% income tax rate, net retirement income comes to only $71K per year. They do however “save” taxes on $480K of contributions = $168,000 at an estimated tax rate of 35%. The difference between the $205K/yr using real estate + life insurance and the $71K/yr via 401K is $134K. So in less than 2 years the real estate + life insurance has already beat the 401K. It even beats the $83K per year if they were able to do a Roth.

Don’t know about you but I sure hope to be in retirement for more than a year and a half.

Hey Nate — It’s ‘retirement advice’ I’m giving, as I don’t claim to be anything else but a RE broker specializing in investing for retirement. I spoke at a conference once when I challenged a guy who kept interrupting me to come up on stage and show folks specifically where I was wrong and exactly why.

However, one unmentioned risk is that your EIUL will be owned by an insurance company that may not exist or be solvent by the time you retire. So you could lose everything. Plus, an EIUL is so incredibly complicated that unless you have it carefully structured by someone who has no financial incentive to rip you off then you are taking a tremendous risk. As I understand it, an insurance company could also modify your contract or raise your fees each year.

Plus, the EIUL seems like a conflict of interest. You’re purchasing a useless life insurance policy for the purpose of retirement income from someone who receives a huge commission from selling it to you. Unless I had a trusted friend set this up, I’d be nervous. Also, any EIUL set up with your interests at heart probably wouldn’t be profitable for the insurance company. If it’s a good deal for you, the insurance company is losing money.

Also, if EIULs are such an obviously good investment vehicle, then why have most people never heard of them?

I’d be hesitant to invest my life savings into a niche product filled with unpenetrable legalese which is completely untested in the court system.

Jack,
FYI, there has not been a life insurance policy that failed to pay out at least since 1900 that I am aware of. If the company would have financial difficulty then other companies come in and buy these policies. The regulatory system on insurance companies is pretty strict as to reserves and what they can invest in. You can further increase your odds by only purchasing policies from top rated companies that have Comdex ratings above 90.

I agree with you that the structuring of these policies is key, that is why I tell people only work with folks who have experience in structuring EIULs for retirement income.
As for modifying the expenses, yes there is the ability to move fees up and down, but in the history of this product, no insurance company has done that to existing policy holders. The flexibility is really about regulatory adherence to the reserves for the companies.

An EIUL is a life insurance policy so there is a death benefit. Most people have a need for a death benefit even if it about estate planning and they have no spouse nor dependents nor heirs. It also leverages your money in the early years so if you were to reach an untimely death your real estate empire could be unwound at the most fortuitous time, not forced to unwind when the market is bad.

Your comment on having a trusted friend set this up is kinda of silly. Do you have a friend set up all your financial dealings? Do you deal with only trusted friends in your real estate dealings or is it a broker/agent you are dealing with? As for the life insurance company [and agent] they do make a good living. Most agents won’t set it up properly because it does lower commissions but there are some that will [like me]. The companies profit does not come into that equation only the agents commission. It’s not an either the company does well or you do well equation. It is possible in this world for companies to offer products and services that provide a win for the purchaser and a win for the company.

Everybody has heard of mutual funds and they are one of the worst retirement vehicles you could get involved in, so the amount of publicity is not correlated with how well the product works for retirement income.

Life insurance is not only tested in the legal system but has been visited many times by the IRS and codified into a set of rules and regulations that dictate how we structure these policies for maximum retirement income.

You are absolutely right that this product is not for you. Never do business with any enterprise or person whom you think is trying to rip you off or for a product you do not understand!